The processes of globalization, in the forms of trade, global value chain and foreign direct investment, have important implications for the labor share in GDP.
Dominant trade theories looked at the gains from trade and the distribution of gains between labor and capital. Also, empirical studies on trade liberalization explored the experiences of trade policy reform in the developing countries and their implications for personal and functional income distribution.
The static ‘gains from trade’ theories saw trade bringing benefits to both capital and labor in the trading countries. Three complementary variants of these theories are dominant in the trade literature. The most influential ‘gains from trade’ theory is the classical Ricardian theory of comparative advantage. This theory argued that countries were different in factor productivity, and specialization in consumption and production would diverge with international trade. Therefore, the country which had a comparative advantage in producing any commodity would export that commodity. Extending the classical comparative advantage trade theory, the Heckscher-Ohlin-Samuelson theorem postulated that since countries had different factor endowments and different factor intensities across goods, the country abundant in labor would export labor-intensive commodities and the country abundant in capital would export capital-intensive commodities. Finally, the theory of vent for surplus (Myint, 1958) argued that, as factors of production were frequently under-utilized in the low-income economies, trade would bring the opportunity of creating low-incomes for unemployed factors of production. Thus, a developing country might be able to gain by exporting the products of factors that would not be employed at all without trade.
Such claims by the ‘static gains from trade’ theories, however, were challenged by the
‘structuralist’ theories on trade which developed during the 1950’s and the 1960’s (Prebisch, 1950; Singer, 1950; Nurkse, 1962; Vernon, 1966). According to the structuralist theories, the
10 industrialized countries were specialized in the production of the income-elastic manufactured goods, while most of the developing countries were the primary commodity producing countries. As primary products were income inelastic, increases in per capita incomes in the rich countries would not significantly increase the demand for primary commodities imported from the developing countries (Nurkse, 1962). Trade would, therefore, act as a source of impoverishment in the developing countries, and the real producers/exporters and labor in the developing countries would gain a little from international trade (Singer, 1950).
As an extension of the ‘structuralist’ theories, Vernon (1966) in his ‘product cycle theory’
argued that there was a substantial technological gap between the developed and developing countries. As innovation of new products took place in the developed countries and this determined the pattern of international trade, this theory recognized the possibility of developing countries exporting manufactured commodities, but only at the stage when products would be well established. Thus, the profit margins from such standardized exports were lower compared to those from the exports of ‘new products’, the development of which remained in the hands of developed countries.
The ideas of ‘structuralist’ theories were rejected by the new orthodoxy of trade liberalization, which emerged during the late 1970’s and early 1980’s. The new orthodoxy emphasized the importance of comparative advantage and free trade for the attainment of overall efficiency, at both the national and global levels (Bhagwati, 1978, 1987; Balassa, 1990).
It was also argued that the promotion of exports would generate several benefits for the liberalized economy which included higher export productivity because of international competitive pressures, exploiting the benefits of operating in enlarged markets, and exploiting different forms of externalities (Bhagwati, 1987).
In contrast to the new orthodoxy, the literature on ‘new trade theories’, emphasized issues, such as learning, scale, market structure, externalities, and institutional influences on trade performance (Brander and Spencer, 1985; Krugman, 1986; Rodrik, 1988). The ‘new trade theories’ suggested that, because of the important roles of economies of scale, advantages of experience and innovation, it seemed more likely that labor and capital would earn significantly higher returns in some industries than in others. A whole range of arguments for intervention or ‘selective’ protection emerged from the ‘new trade theories’ (Rodrik, 1988;
Pack and Westphal, 1986; Lall, 1990).
Against the backdrop of the theories, the findings of empirical literature remained inconclusive when it comes to the processes of globalization, in the forms of trade liberalization, foreign direct investment and global value-chain, and their impacts on income distribution. Though globalization is argued to raise the level of income and foster the national economy, its specific effect on labor and its overall distributional impact is controversial, given that not all groups of the society are able to take advantage of its benefits (Wood, 1994;
Robbins, 1996; Dollar and Kraay, 2001; Sen, 2001; Harrison et al 2011). A limited number of studies, however, attempted assessing the impact of globalization on the labor share (Harrison, 2002; Guscina, 2006; EC, 2007; IMF, 2007; Suzuki et al, 2019). These studies, using computed indices of labor share in GDP, showed a declining trend of labor share and explored
11 the factors behind the trend. Suzuki et al (2019) found that trade openness is negatively correlated with the labor income share.
Guerriero and Sen (2012) summarized three hypotheses on the effect of globalization through the global value chain and the process of outsourcing on the labor share. First, as proposed by Jayadev (2007), when firms reallocate capital to other countries for production, they outsource labor intensive production to countries with lower wages and consequently decrease domestic demand of labor and the labor share. Second, as proposed by Krugman (2008), when companies in industrialized economies offshore some of their activities to the South, developing countries take over only labor-intensive portions of skilled-intensive industries, so no substantial change would occur in the pattern of trade and specialization of developed and developing economies suggested by mainstream theory. Third, as argued by Grossman and Rossi-Hansberg (2008), off-shoring and trade in intermediates can be Pareto-improving phenomena, generating productivity-enhancing effects for domestic labor, accelerating innovation, and improving welfare.
That FDI modifies the factor distribution of output in the host country is ubiquitous in the literature. Most of the papers focus on wage inequality and display mixed evidence in favor of the thesis that FDI causes wage inequality, either at industry level or country level.
Important theoretical contributions include Liang and Mai (2003), Marjit et al (2004), and Das, 2005. Decreuse and Marrek (2015) addressed the effects of FDI on the labor share in developing countries. Their theory relied on the impacts of FDI on wage and labor productivity in a frictional labor market. FDI has two opposite effects on the labor share: a negative one originated by technological advance, and a positive one due to increased labor market competition between firms. The net effect would depend on the relative strength of these two opposite effects.
Empirical literature also looked at other factors affecting the labor share in GDP. These are technological development, structural transformation, social policies, and labor market institutions.
Technological change seems to have boosted the returns to capital while depressing the returns to labor (IMF, 2001; Acemoglu, 2002; Bentolila and Saint-Paul, 2003). It is generally argued that since the early 1980s, technological change has become capital-augmenting, rather than labor-augmenting (Bentolila and Saint-Paul, 2003; Guscina, 2006; Lawless and Whelan, 2011). The introduction of Information and Communication Technologies (ICTs) and other new technologies contributed to the decline of the labor share around the world (IMF, 2001; Ellis and Smith, 20072). O’Mahony et al (2019) argued that in the long run, productivity upgrades and information and communication technology capital diffusion were the major sources of the decline in the labor share. There are also counterarguments related to the impact of technology on the labor share. While machinery generally substitutes unskilled labor, it also complements skilled labor, and therefore, with the introduction of new machines and new technology, extra training and learning for those people who have to work with them lead to an increase in their levels of education and their labor productivity (IMF, 2007).
2 Ellis and Smith (2007) proposed the hypothesis that technological progress and mechanization in ICT-related capital goods, increased the rate of depreciation and obsolescence of capital goods, putting firms in a stronger bargaining position compared to the labor force.
12 Therefore, it is not clear what the overall impact on labor would be (Arpaia et al, 2009). For example, the empirical works by Das (2019) pointed to a dominant role of both technology and globalization, although to very different degrees in developed versus developing Asian economies. While technological progress was the key driver in advanced Asia, with globalization playing a smaller contributing role, in developing Asia, the evolution of labor shares was driven predominantly by the forces of globalization, with a very limited role for technology.
The level of economic development is one of the most important determinants of the labor share (Lewis, 1955; Kravis, 1959; Kuznets, 1955). As poor economies are dominated by a traditional agricultural sector with very low wages and a big surplus of labor (Lewis, 1955), the few capitalists in the modern sector can hire labor at minimal wages; therefore, productivity gains are not compensated by wage increases (Jayadev, 2007; Maarek, 2010;
Ortega and Rodriguez, 2006), and the labor share remains at very low levels. As the economy develops, productivity increases, and greater segments of the workforce start moving from the traditional agricultural sector into positions of organized wage labor in the modern sector.
Wages will rise, as well as employment, because of the presence of unlimited supply of labor:
an increasingly larger share of income will be earned by workers as opposed to entrepreneurs (Kravis, 1959; Kuznets, 1955). However, with the economy growing more and more, the mechanism will necessarily reduce its magnitude and other dynamics will come into place:
the effect of rising wages is stronger for low levels of development (Daudey and Garcia-Peñalosa, 2007). Suzuki et al (2019) found that the relationship between the process of structural transformation and labor income share was at best mixed. Their study found weak evidence that skill-biased structural transformation was likely to be positively correlated with the share of labor income predominantly in the services sectors.
Studies by Diwan (2001), Daudey and Garcia-Peñalosa (2007), and Luo and Zhang (2010) showed that the labor share would be affected by the amount of human capital that workers possess. Higher educational attainment influences labor through its effect on wages and employment. An increase in the level of human capital, raising the levels of wages and employment, is expected to increase the numerator of the share (Daudey and Garcia-Penalosa, 2007).
In the case of labor market institutions, studies argued that pro-worker labor institutions have an important and positive redistributive role in the economy, restoring the equilibrium between capital and labor, and counteracting possible negative effects generated by asymmetries in economic power between workers and employers (ADB, 2005; EC, 2007).
Related to the discussion on pro- worker labor institutions, the empirical analysis of Guerriero (2019) showed that democracy allowed workers to appropriate a higher share of national income. However, labor regulations may produce ambiguous effects on employment (Nickell and Layard, 1999; Besley and Burgess, 2004) and poorly designed institutions may generate
‘perverse’ effects, given that they impact only on the organized sector of the economy (Dougherty, 2008). Also, the stratification of labor can have strong implications on measured labor income and labor share, beyond institutions. A small share of workers with extremely high human capital (or other means of ensuring extremely high labor income) may distort the overall picture (ILO, 2019).
13